Economic and financial principles

1 Water has an economic value and should be recognised as a social and public good

Recognition of freshwater as a finite resource has led to the emergence of the principle that water is a social and public good but one to which a price for provision services connected to it can be attached. The application of this principle becomes increasingly critical as water becomes more scarce. However, this principle should not over-ride the social imperative of providing a basic supply of safe water for every human being.

Applying an economic value to water can require the attachment of different values linked to different uses of water. These values will vary from setting to setting depending upon the user population, although it is invariably the case that survival and public health uses will be of high value; whereas recreational uses are often comparatively lower value. Where water is scarce, it is often good management to discourage low-value uses. The objective of reallocating sufficient water from low-value to high-value purposes should be investigated as an alternative to, or in parallel with, developing new sources of supply. In this context, the use of water markets can be appropriate. Some estimates of high and low-value uses of water may benefit from considering the importance of “virtual water” i.e. the non-evident water embedded in imported food crops, and “water foot printing”. However water foot printing remains largely an accounting process, and elements of environmental and ecological responsibility as well as governance principles need to be included in evaluating the water resource.

Allocation of values to water uses helps in the following areas: balancing scarce resources with increasing demand; focussing attention on reduction of wastage and loss; conservation of the resource; and shifts in consumption towards higher value uses.

2 Charging tariffs for water services is an important component of any strategy for sustainability

Charging for water services (water supply, irrigation and wastewater disposal and re-use) is essential in order to generate funds for operating, maintaining and investing in systems; ensure that scarce supplies are allocated to essential purposes; and serves as a signal to users that a real financial value can be applied to the resource. Theoretically, a service which provides water to customers should not do so for free, even to the poorest customer. However, this principle poses a dilemma: how to provide a basic service to those who are extremely poor and yet ensure cost recovery, especially in areas where the costs of water extraction and delivery are high and/or continually mounting due to pressure on the resource.

Some basic solutions exist. For households’ consumption, a certain minimum volume necessary for basic needs can be provided at an affordable price, with higher-level volumes subject to higher tariffs (solidarity principle / cross subsidising). This will ensure that higher levels of consumption are not subsidised. Public subsidies are legitimate when applied to achieve certain social benefits (for example, provision of supplies to the underprivileged and under-served). However, these subsidies need to be transparent, targeted, and budgetary practical and sustainable (for example, covered by surpluses generated elsewhere).

The weighted average of the tariffs should be high enough to recover, at a minimum, recurrent operations and maintenance costs. Where water charges have been increased for this purpose, the aim should be to raise them progressively, and with due regard for continuing to meet basic needs and to the full marginal cost (equivalent to the average incremental cost of future supply) in order to also generate resources for expanding or modernising the system. Industrial water tariffs need to take into account the volume of water they extract, and the volume and quality of water returned to public water bodies. For example, OECD members have accepted the principle that ‘polluters pay’: those who dispose carelessly of wastewater should be charged for their actions.

If the tariff structure is progressively higher for increased consumption levels, they provide an incentive to conservation. Higher tariffs also generate extra resources for expanding services, although the practicalities of recovering costs for service installation and extension will depend on conditions (physical and socio-economic) operating in a given setting. The same principles apply to wastewater disposal and management.

3 “Demand management” should be used in conjunction with supply provision

Demand management seeks to maximise the usage of a given volume of water, by curbing inessential or low-value uses through price or non-price measures. In water-scarce areas, it is necessary to gain political support for demand management over supply-led solutions (the latter referring to solutions which are based on indefinite expansion of services and supplies).

A number of demand management measures can be considered, including market-based incentives such as water tariffs, pollution charges, water markets, water banking; and non-market incentives, such as leakage control, restrictions, quotas, norms, licenses and promoting re-use and recycling practices Alternative technologies, such as promoting dry sanitation methods of water conservation, can also contribute.. All options need to be systematically identified and appraised. These appraisals need to be conveyed to the end-users and local authorities so informed choices can be made, leading to effective demand driven solutions.

In its policies towards key sectors such as industry and agriculture, a government and the population should be made aware of the potential negative impacts from developing water-intensive industries or agriculture in regions where water is scarce and estimates of different water values suggest that it should be applied to other uses.